Comprehensive guide for US companies to properly deduct expenses when hiring contractors in South Korea.

Table of Contents

Quick Answer

To deduct contractor expenses for a South Korean contractor, you need:

✅ Required

  1. Form W-8BEN - Collect from contractor (keep on file, don’t submit to IRS)
  2. Written contract - Documenting the business relationship
  3. Invoices - Detailed invoices for services rendered
  4. Payment records - Bank statements or wire transfer confirmations
  5. Documentation - Keep all records for at least 3 years

❌ NOT Required (in most cases)

  • No Form 1099-NEC - Not required for foreign contractors working outside US
  • No Form 1042-S - Generally not required if services performed entirely outside US
  • No withholding - No US tax withholding if work done outside US

Key Principle

If the contractor is in South Korea performing ALL work from South Korea, the income is not US-sourced and standard US contractor reporting doesn’t apply.

IRC Section 162: Trade or Business Expenses

Legal Basis: Internal Revenue Code Section 162(a) allows deduction of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Five Requirements for Deductibility:

  1. ✅ An expense (not capital expenditure)
  2. ✅ Ordinary (normal and widespread in your industry)
  3. ✅ Necessary (appropriate and useful to the business)
  4. ✅ Paid or incurred during the taxable year
  5. ✅ Made to carry on a trade or business

Definitions:

  • “Ordinary”: Normal and widespread in the type of business at issue
  • “Necessary”: Not absolutely essential, but appropriate and useful to the business

Foreign Contractor Payments: Payments to foreign contractors for services qualify as ordinary and necessary expenses if they meet business purposes, regardless of the contractor’s location.

US-South Korea Tax Treaty

Treaty Benefits

Original Treaty: Signed in 1976 between US and Republic of Korea Purpose: Prevent double taxation and provide relief for taxpayers

Independent Contractor Provisions

Income Exemption: Income that South Korean residents receive for performing personal services as independent contractors is exempt from US tax if:

  1. ✅ In the US for no more than 182 days during the tax year
  2. ✅ Earn no more than $3,000 from US sources during the tax year
  3. ✅ Do NOT maintain a fixed base in the US

Typical Scenario: Contractor working 100% from South Korea = No US tax, no withholding required

Fixed Base Rule

If contractor maintains fixed base in US for more than 182 days:

  • Subject to US tax on income attributable to the fixed base
  • Different reporting requirements apply
  • Withholding may be required

Required Documentation

1. Form W-8BEN (Certificate of Foreign Status)

Purpose: Establishes that the contractor is a foreign person, not subject to US tax withholding

Who Completes: The South Korean contractor (individual) Alternative for Entities: Form W-8BEN-E (for corporations or LLCs)

Key Information on Form:

  • Contractor’s name and address
  • Country of citizenship
  • Permanent residence address
  • Tax identification number (if available)
  • Treaty claim (if applicable)
  • Signature and date

Important:

  • ✅ Keep on file for 3 years from date received
  • ✅ Update if circumstances change
  • ❌ Do NOT submit to IRS
  • ❌ Do NOT file with tax return

Validity Period: Generally valid for 3 years or until circumstances change

Example W-8BEN Use Case:

Contractor: Kim Min-jun
Country: South Korea
Permanent Address: Seoul, South Korea
Claim: Services performed entirely in South Korea
Result: No US tax withholding required

2. Written Contract

Purpose: Establishes business relationship and terms

Should Include:

  • Names and addresses of both parties
  • Scope of work/services to be provided
  • Payment terms and rates
  • Duration of engagement
  • Independent contractor status acknowledgment
  • Governing law (US or South Korean)
  • Intellectual property rights
  • Confidentiality provisions
  • Termination clauses

Best Practices:

  • Clear description of deliverables
  • Payment schedule (hourly, project-based, milestone-based)
  • Currency specification (USD, KRW, or other)
  • Payment method (wire transfer, PayPal, Wise, etc.)

3. Invoices

Purpose: Substantiate the expense for tax deduction

Required Information:

  • Invoice number and date
  • Contractor’s name and address
  • Your company name and address
  • Detailed description of services performed
  • Hours worked or project milestones completed
  • Rate and total amount due
  • Payment terms
  • Currency (preferably USD or with exchange rate)

Best Practices:

  • Monthly invoices preferred for ongoing work
  • Keep in English or with English translation
  • Match invoice dates to payment dates
  • Include period covered (e.g., “Services for January 2025”)

Example Invoice Format:

INVOICE #2025-001
Date: January 31, 2025


From: Kim Min-jun
      Seoul, South Korea


To: Your Company Inc.
    123 Main St, New York, NY


Services: Software development services for January 2025
- Backend API development: 80 hours @ $75/hr = $6,000
- Code review and testing: 20 hours @ $75/hr = $1,500


Total: $7,500 USD
Payment Terms: Net 15

4. Payment Records

Purpose: Prove payment was actually made

Required Documentation:

  • Bank statements showing wire transfers
  • Credit card statements (if applicable)
  • Payment platform records (Wise, PayPal, Payoneer)
  • Foreign exchange transaction records
  • Payment confirmations with transaction IDs

Best Practices:

  • Match payment amounts to invoices
  • Keep records of exchange rates used
  • Document payment processing fees separately (also deductible)
  • Track payment dates for cash vs. accrual accounting

Example Payment Record:

Date: February 10, 2025
Amount: $7,500 USD
Recipient: Kim Min-jun (South Korea)
Method: Wire transfer via Wise
Transaction ID: WS-2025-02-10-12345
Exchange Rate: 1 USD = 1,320 KRW (if paid in KRW)
Fee: $15.00 (also deductible)

For Enhanced Audit Protection:

  • Email correspondence regarding work assignments
  • Project deliverables or work product
  • Time tracking records
  • Meeting notes or progress reports
  • Change orders or amendments to contract

Tax Forms - What’s Required and What’s Not

❌ Form 1099-NEC - NOT Required

General Rule: No Form 1099-NEC required for foreign contractors if:

  • Contractor is NOT a US person (citizen or resident)
  • ALL services performed OUTSIDE the United States
  • Country has tax treaty with US (South Korea qualifies)

Exception - Form 1099-NEC IS required if:

  • Contractor performs services physically IN the United States
  • Contractor is a US citizen or resident alien
  • Pay $600 or more during the tax year

Why Not Required: Form 1099-NEC is for reporting US-sourced income. Services performed entirely in South Korea are not US-sourced income.

❌ Form 1042-S - Generally NOT Required

General Rule: Form 1042-S is for reporting payments to foreign persons subject to withholding

When NOT Required:

  • Services performed entirely outside the US
  • Income not US-sourced
  • No withholding obligation under tax treaty

When Form 1042-S IS Required:

  • Contractor performs services in the US
  • Income is US-sourced (location-specific services)
  • Withholding applies even if reduced by treaty
  • Royalties, dividends, or other passive income

Filing Deadline (if required): March 15 of following year

Important Note: Some sources suggest Form 1042-S may be required even for treaty-exempt income to report the exemption. Consult a tax professional if:

  • Payment exceeds $25,000
  • Complex arrangement with US-based deliverables
  • Uncertainty about source of income

✅ Form W-8BEN - REQUIRED

Purpose: Establishes foreign status and treaty benefits Who Completes: Contractor Your Action: Collect and keep on file for 3 years IRS Submission: NOT required (keep in your records only)

Withholding Requirements

No Withholding for South Korea Contractors (Typical Case)

Standard Rule: No US tax withholding required if:

  • ✅ Services performed 100% in South Korea
  • ✅ Valid Form W-8BEN on file
  • ✅ Contractor is South Korean resident
  • ✅ No fixed base in US

Result: Pay contractor full amount, no withholding

When Withholding IS Required

30% Withholding Applies if:

  • Contractor performs services IN the United States
  • No valid Form W-8BEN on file
  • Cannot verify foreign status
  • Income is US-sourced

Backup Withholding (24%):

  • Cannot obtain valid Tax Identification Number
  • Contractor fails to provide Form W-8BEN

Reduced Treaty Rates:

  • May apply for specific types of income
  • Requires proper documentation
  • File Form 8833 for treaty-based positions (in some cases)

Currency and Exchange Rate Requirements

Currency Conversion Rules

IRS Requirement: All foreign currency must be converted to US dollars for tax reporting

Exchange Rate to Use:

  • Transaction date rate - Use exchange rate from the date of payment
  • Average annual rate - Acceptable for routine transactions
  • IRS Published Rates - Available on IRS website for most currencies

South Korean Won (KRW) Conversion:

Example:
Payment date: February 10, 2025
Amount in KRW: ₩9,900,000
Exchange rate: 1 USD = 1,320 KRW
USD Amount: ₩9,900,000 ÷ 1,320 = $7,500

Sources for Exchange Rates:

Record-Keeping Best Practices

Create Tracking Spreadsheet:

DateInvoice #DescriptionKRW AmountExchange RateUSD AmountPayment Method
2/10/252025-001Dev services₩9,900,0001,320$7,500Wise

Save Exchange Rate Documentation:

  • Screenshot from IRS website
  • Payment platform confirmation showing rate used
  • Bank wire transfer confirmation with FX rate

Deduction Methodology

Accounting Method

Cash Basis:

  • Deduct expense when paid
  • Most small businesses use cash basis
  • Simpler record-keeping

Accrual Basis:

  • Deduct expense when incurred (invoice date)
  • Required for businesses with >$25M revenue
  • Matches expenses to revenue period

Tax Return Reporting

Where to Report (Sole Proprietor):

  • Schedule C, Line 11 - Contract Labor
  • Include total payments to contractors in the year

Where to Report (Corporation):

  • Form 1120, Line 26 - Other Deductions
  • Or include in Line 12 - Compensation of Officers (if applicable)
  • Or Line 13 - Salaries and wages (though technically contract labor)

Where to Report (Partnership):

  • Form 1065, Line 10 - Guaranteed payments
  • Or Line 20 - Other deductions

Schedule C Example:

Schedule C (Form 1040)
Line 11: Contract Labor
Amount: $90,000 (total payments to all contractors for year)

What’s Deductible

Fully Deductible:

  • ✅ Contractor payments for services
  • ✅ Payment processing fees (wire transfer fees, Wise fees, etc.)
  • ✅ Currency exchange fees
  • ✅ Bank charges for international payments
  • ✅ Legal fees for contract preparation
  • ✅ Background check costs

Not Deductible:

  • ❌ Penalties for late payment (unless business-related)
  • ❌ Illegal payments or bribes
  • ❌ Personal expenses mixed with business

Record Retention Requirements

IRS Requirements

Minimum Retention Period: 3 years from date of filing return

Best Practice Retention: 7 years (covers extended audit periods)

What to Keep:

  • ✅ Form W-8BEN (3 years from receipt)
  • ✅ Contracts (duration + 7 years after end)
  • ✅ Invoices (7 years)
  • ✅ Payment records (7 years)
  • ✅ Bank statements (7 years)
  • ✅ Email correspondence (3-7 years)
  • ✅ Work product/deliverables (3-7 years)

Storage Methods:

  • Digital scans (PDF format recommended)
  • Cloud storage with backup
  • Physical filing for originals
  • Encrypted for sensitive information

Audit Protection

IRS May Request:

  • Proof of payment
  • Proof services were actually rendered
  • Business purpose documentation
  • Contract terms
  • Correspondence with contractor

Strong Audit Trail:

  1. Contract clearly defines services
  2. Invoices match contract terms
  3. Payments match invoice amounts
  4. Work product demonstrates value received
  5. Business purpose is documented

Common Mistakes to Avoid

❌ Mistake 1: Not Getting Form W-8BEN

Problem: Without W-8BEN, you may be required to withhold 30% tax Solution: Request W-8BEN before first payment, keep on file

❌ Mistake 2: Issuing Form 1099-NEC to Foreign Contractor

Problem: Not required, creates confusion, may trigger unnecessary IRS notices Solution: Only issue 1099-NEC if contractor worked IN the US

❌ Mistake 3: Poor Invoice Documentation

Problem: IRS may disallow deduction without proper substantiation Solution: Require detailed invoices with description of services

❌ Mistake 4: Not Converting Currency Properly

Problem: Incorrect deduction amounts, potential audit issues Solution: Use proper exchange rates, document source

❌ Mistake 5: Mixing Personal and Business Payments

Problem: Personal expenses not deductible, audit risk Solution: Keep clear separation, only deduct business-related payments

❌ Mistake 6: Not Documenting Business Purpose

Problem: IRS may question necessity of expense Solution: Keep notes on why contractor was hired, what business need was met

❌ Mistake 7: Expired W-8BEN Forms

Problem: W-8BEN expires after 3 years or if circumstances change Solution: Renew W-8BEN every 3 years, track expiration dates

❌ Mistake 8: Assuming All Foreign Payments Are the Same

Problem: Different rules for employees vs. contractors vs. royalties Solution: Classify relationship correctly, apply appropriate rules

Step-by-Step Process

Before Hiring

Step 1: Verify Contractor Status

  • Confirm contractor is South Korean resident
  • Confirm services will be performed in South Korea
  • Classify as independent contractor, not employee

Step 2: Prepare Contract

  • Draft written agreement
  • Include key terms (scope, payment, duration)
  • Specify independent contractor relationship

Step 3: Collect Form W-8BEN

  • Send blank W-8BEN to contractor
  • Review completed form for accuracy
  • Keep on file (don’t send to IRS)

During Engagement

Step 4: Receive Invoices

  • Request detailed monthly invoices
  • Verify invoice accuracy
  • Match to contract terms

Step 5: Process Payments

  • Pay via wire transfer, Wise, or other method
  • Keep payment confirmations
  • Document exchange rates
  • Track payment processing fees

Step 6: Track Expenses

  • Record in accounting system
  • Categorize as contract labor
  • Note currency conversions

At Tax Time

Step 7: Prepare Tax Return

  • Total all contractor payments for the year
  • Report on appropriate tax form line
  • Include payment processing fees

Step 8: Organize Records

  • Compile all invoices
  • Gather payment records
  • Ensure W-8BEN is current
  • Store securely for 7 years

Step 9: Verify Deduction

  • Confirm ordinary and necessary
  • Ensure proper substantiation
  • Cross-check amounts

If Audited

Step 10: Respond to IRS

  • Provide Form W-8BEN
  • Show contract and invoices
  • Demonstrate business purpose
  • Prove payments made
  • Explain why no 1099-NEC issued

Special Considerations

Multiple Contractors

If hiring multiple South Korean contractors:

  • Collect separate W-8BEN for each
  • Track payments separately
  • Consider aggregate reporting needs
  • Monitor total contract labor deduction

Aggregate Limits:

  • No specific limit on contract labor deductions
  • Must be ordinary and necessary
  • Should be proportional to business size
  • Excessive amounts may trigger scrutiny

Long-Term Relationships

For contractors engaged multiple years:

  • Renew W-8BEN every 3 years
  • Update contracts annually
  • Review payment terms regularly
  • Maintain consistent documentation

Hybrid Arrangements

If contractor works both in US and South Korea:

  • Allocation required between US and foreign source
  • Different reporting for US-source income
  • May need Form 1099-NEC for US portion
  • May need withholding on US portion
  • Consult tax professional

Entity vs. Individual

If hiring South Korean company (not individual):

  • Use Form W-8BEN-E (entity version)
  • Same general principles apply
  • May have different treaty provisions
  • Check for permanent establishment issues

Tax Treaty Form 8833

When Required

Form 8833 Purpose: Disclose treaty-based return positions

Generally NOT required for:

  • ✅ Reduced withholding on dividends, interest, royalties
  • ✅ Employee compensation
  • ✅ Standard contractor arrangements

May be required for:

  • Complex treaty positions
  • Claiming exemption beyond standard rates
  • Taking position contrary to IRS regulations

Safe Harbor: Not required for routine contractor payments entirely outside US

How to File (if needed)

Attachment: Attach to Form 1040, 1120, or 1065 Information Required:

  • Treaty article claimed
  • Provision overruled
  • Explanation of position

State Tax Considerations

State Income Tax

General Rule: Most states follow federal treatment

No State Reporting Typically Required:

  • Contractor not physically in your state
  • No state source income
  • No withholding obligation

Exception - Nexus States:

  • If contractor creates nexus in state
  • If services benefit state operations
  • Check state-specific rules

States with Unique Rules:

  • California - aggressive nexus rules
  • New York - convenience of employer rule
  • Other states may vary

Best Practice: Consult state tax professional if uncertain

Payment Methods

Wire Transfer (Bank to Bank):

  • ✅ Professional and traceable
  • ✅ Clear documentation
  • ❌ Higher fees ($25-45 per transfer)
  • ❌ Slower (2-5 business days)

Wise (formerly TransferWise):

  • ✅ Lower fees (typically 0.5-1.5%)
  • ✅ Fast (1-2 business days)
  • ✅ Good exchange rates
  • ✅ Clear documentation

PayPal:

  • ✅ Fast and convenient
  • ❌ Higher fees (3-5%)
  • ⚠️ Some contractors may not accept

Payoneer:

  • ✅ Popular for international contractors
  • ✅ Reasonable fees
  • ✅ Multi-currency accounts

Cryptocurrency:

  • ⚠️ Complex tax treatment
  • ⚠️ Additional reporting requirements
  • ⚠️ Exchange rate volatility
  • ❌ Not recommended without expert advice

Payment Documentation

For Each Payment, Keep:

  • Transaction ID or confirmation number
  • Date of payment
  • Amount in USD and KRW (if applicable)
  • Exchange rate used
  • Fees charged
  • Recipient details
  • Purpose/invoice reference

Risk Assessment

Low Risk Indicators

Your situation is likely low risk if:

  • ✅ Contractor entirely in South Korea
  • ✅ Valid W-8BEN on file
  • ✅ Clear contract and invoices
  • ✅ Reasonable payment amounts
  • ✅ Regular payment pattern
  • ✅ Work product demonstrates value
  • ✅ Payments match industry norms

Higher Risk Indicators

May trigger additional scrutiny if:

  • ⚠️ Very large payments (>$100k annually)
  • ⚠️ No written contract
  • ⚠️ Vague invoice descriptions
  • ⚠️ Contractor is related party
  • ⚠️ No W-8BEN on file
  • ⚠️ Irregular payment patterns
  • ⚠️ Payments seem excessive for services

Audit Triggers

More likely to be questioned if:

  • Large disproportionate to revenue
  • Pattern of contractor payments increasing while employee costs decrease
  • Same contractor reclassified from employee
  • Payments to high-risk jurisdictions (South Korea is NOT high-risk)
  • No business purpose documentation

When to Consult a Professional

  • ✅ First time hiring foreign contractors
  • ✅ Payment over $50,000 annually
  • ✅ Contractor will work partially in US
  • ✅ Complex arrangement with multiple deliverables
  • ✅ Uncertainty about employee vs. contractor classification
  • ✅ State tax nexus concerns
  • ✅ Multiple foreign contractors in different countries
  • ✅ Planning to hire employees (not contractors) in South Korea

Types of Professionals

CPA (Certified Public Accountant):

  • Tax return preparation
  • General tax advice
  • Audit support

International Tax Attorney:

  • Complex treaty issues
  • Legal structure advice
  • IRS controversy representation

Tax Advisor Specializing in International:

  • Foreign contractor compliance
  • Multi-jurisdiction planning
  • Transfer pricing issues

Resources

IRS Resources

Official Guidance:

Tax Treaty:

Exchange Rates:

Forms

Download Forms:

  • Form W-8BEN - Certificate of Foreign Status (Individual)
  • Form W-8BEN-E - Certificate of Foreign Status (Entity)
  • Form 1042-S - Foreign Person’s US Source Income (if needed)
  • Form 8833 - Treaty-Based Return Position Disclosure

Private Resources

Payment Platforms:

  • Wise - International money transfers
  • Payoneer - Cross-border payments
  • PayPal - International payments

Information Sites:

  • TaxBandits, Collective, Deel - Foreign contractor guidance
  • PWC, Deloitte Country Guides - Tax summaries by country

Summary Checklist

✅ Before First Payment

  • Signed written contract in place
  • Received completed Form W-8BEN
  • Verified contractor is in South Korea
  • Confirmed services performed outside US
  • Set up record-keeping system

✅ For Each Payment

  • Received detailed invoice
  • Verified invoice matches contract
  • Processed payment with documentation
  • Recorded exchange rate (if applicable)
  • Saved payment confirmation
  • Recorded in accounting system

✅ Annually

  • Totaled all contractor payments
  • Verified W-8BEN still valid (not expired)
  • Reported on appropriate tax form line
  • Confirmed no 1099-NEC required
  • Organized records for retention

✅ For Audit Protection

  • All W-8BEN forms on file (3+ years)
  • All contracts saved (7+ years)
  • All invoices organized (7+ years)
  • All payment records accessible (7+ years)
  • Business purpose documented
  • Work product retained as evidence

Last Updated: 2025-11-06 Based on: IRS regulations, US-Korea Tax Treaty, IRC Section 162

Disclaimer: This document is for informational purposes only and does not constitute legal or tax advice. Tax laws are complex and change frequently. Always consult with a qualified tax professional or CPA for advice specific to your situation.